Market action is looking a tad manic, yet the dot-com mania proved that unwarranted optimism can persist far longer than cooler heads deem possible. Hedge fund leverage, for instance, is allegedly back to pre-crisis highs. And various market commentators are pointing to worrisome echoes of dot-com type preferences, where stocks amenable to fantasy, or what Bill Fleckenstein calls “imagination” are preferable to ones with clearly better prospects
...former believers are getting a tad edgy. For instance, Morgan Stanley warned at the end of last week that corporate profit increases were due to become a thing of the past. From the summary of its note “The Coming Flattening in US Profit Margins”:
Earnings deceleration despite economic acceleration: We think earnings growth will slow significantly despite a moderate US economic acceleration in 2011. The culprit: A coming flattening in profit margins due to slowing output growth abroad, fading operating leverage, and an end to the decline in interest expense.But for now, the answer is obvious, which is play the imagination theme to the hilt. Thus a Financial Times comment gave very bad advice to Facebook’s Mark Zuckerberg, telling him to give up his hoodie and dress like a proper CEO. Nonsense. The youthful look is as much part of his brand as Steve Job’s signature black T-shirts, and key to the fantasy that social media as eternally youthful, and therefore with continuing growth prospects.
Four reasons margins have soared: 1) Strong growth abroad, especially in the booming EM economies, that lifted results of US affiliates abroad; 2) capital discipline that enabled companies to exploit their operating leverage and boost ROICs; 3) strong control over balance sheets that has kept a taut rein on interest expense; and 4) hiring discipline that reduced total compensation, especially the fixed costs of healthcare benefits.
Four sources of flatter margins in 2011: 1) Growth in overseas output is likely to slow somewhat; 2) operating leverage will fade as fixed costs like depreciation start to catch up to sales; 3) declines in interest expense will end; and 4) for some companies, rising commodity prices will foster margin compression.
So enjoy the ride while it lasts. As with the credit mania of 2007, investors will assume they can get through the exits when the party stops. And some did, but many were trampled in the ensuing panic.
---source (nb - she also quotes Rosenberg)
Post a Comment